Commentary: Inflation Shook the Markets This Week—But Deflation Is the Force to Watch

Investors got spooked this week by the specter of rising interest rates and inflation, and what they might mean for the global economy.

But they should look just as hard at deflation, which in recent years has been neutralizing inflation’s impact on wages and prices—with the notable exception of asset prices.

I believe deflation has become structural and is here to stay, no matter what interest rates do. Recent innovations like ecommerce and fracking have strengthened deflation’s grip on prices, people, and jobs. Everything that can be produced with technology just keeps getting cheaper and cheaper.

How did this happen? In the mid-1990s, consumer prices started falling and never looked back. Cheap overseas labor, global trade agreements, containerization, and the emergence of big box stores and mass-discount retailers all drove this trend. By the 2000s, Internet shopping had kicked in, making it easy to value shop, and challenging brand loyalty.

In tandem with the rise of ecommerce, hydraulic fracturing (fracking) technology began wiping out the global balance of energy supply and demand, unleashing massive price wars. Between 2013 and 2016, you had to double your efficiency to survive in the U.S. oil production business; this drove increasing automation to slash costs. American fracking technology not only deflated global energy costs, but helped deflate any sector using energy as a major input.

But deflation’s biggest impact is yet to come. Eighty percent of jobs in the U.S. are in services, and almost all are on a path to getting deflated and commoditized. U.S. wages have been deflating for 20 years to the surprise of most economists, especially given the recently booming economy.

Today’s service workers must compete with job deflators powered by software and winner-take-all economies of scale. Services like Airbnb, Netflix, DocuSign, Venmo, exchange-traded funds (ETFs), and TurboTax are sucking costs out of every sector, as consumers and businesses choose cord-cutting flexibility, on-demand convenience, and lower costs.

While service workers must compete as commodities in the newly transparent gig economy, corporate payrolls are slimming down to survive the new competition. A few big-name stars can swim against his tide (think Taylor Swift or partners at Goldman Sachs), but most service workers—from doctors to artists—are feeling the squeeze.

Deflation’s final frontiers are health care and education, which have been insulated because consumers don’t pay their costs directly (employers and the government do). But now that that’s changing too, there’s nowhere to hide.

Where will this all end? At some point, deflation’s implied low margins should catch up with the valuations of all but a small handful of dominant companies. Whether that’s triggered by higher rates or some other catalyst is hard to say.

What I do know is that technology-driven deflation is a primal force that will shape the rest of our lives. Tell your children and your investment advisor. Like gravity, we’ll all have to figure out how to live with it.